In a shift, Fed will be 'patient' on future U.S. rate hikes

By Howard Schneider and Jason Lange

WASHINGTON (Reuters) - The U.S. Federal Reserve on Wednesday held interest rates steady and, in a formal policy shift, vowed to be patient in further lifting borrowing costs, the clearest signal yet the tightening cycle it began in 2015 may have ended. Citing rising uncertainty about the U.S. economic outlook, Fed Chairman Jerome Powell said the case for raising rates had "weakened" and, in a statement, the U.S. central bank dropped its earlier expectation for "some further" tightening. The Fed also shifted to a more dovish stance on its ongoing shedding of assets, saying it was prepared to adjust its plans based on economic and financial developments. Powell, speaking to reporters after the end of the Fed's latest two-day policy meeting, said the central bank would likely stop trimming its $4.1 trillion balance sheet sooner, leaving it with more assets than previously expected. "The situation now calls for patience," he said, referring to the prospect of further rate hikes. "I think it's the right thing. I feel strongly that it is." Taken together, the balance sheet announcement and the shift on rate hikes was meant to convey maximum flexibility from a central bank buffeted in recent weeks by financial market volatility, signs of a global economic slowdown and a partial U.S. government shutdown that clouds the economy. "This marks a full 180 from what the Fed was signaling just a few months ago," said Mohamed El-Erian, chief economic adviser at Allianz, in Newport Beach, California. After the Fed statement, U.S. stocks added to gains with the S&P 500 index rising 1.5 percent, while the dollar and short-term yields fell as investors gauged an even lower probability of additional rate hikes any time soon. Market expectations of future rates fell further. Contracts tied to the Fed's policy rate continued to price about a one-in-four chance of a hike in 2019, and contracts maturing in 2020 were signaling a small but rising chance of a rate cut then. The Fed's policy statement left its overnight benchmark lending rate in a target range of 2.25 percent to 2.50 percent. The U.S. central bank said continued economic and job growth was still "the most likely" outcome. But it removed language from its December policy statement that risks to the outlook were "roughly balanced." CLOUDIER OUTLOOK The Fed raised rates four times last year including in December, when it signaled it would do so twice more this year. The economic outlook, however, has become more clouded as a result of recent volatility in financial markets and signs that growth is slowing overseas, including in China and the euro zone. There are also fears the 35-day partial shutdown of the U.S. government may crimp consumer spending. "In light of global economic and financial developments and muted inflation pressures, the committee will be patient" in determining future rate hikes, the Fed's rate-setting committee said in the policy statement. The Fed made no change to the $50 billion maximum monthly runoff of Treasury bonds and mortgage-backed securities from its balance sheet. Some traders have urged it to slow or halt its pullback from the bond markets, at least for now. In a separate statement, the Fed that it had decided to continue managing policy with a system of "ample" reserves, reinforcing the notion that the rundown may end sooner than expected. "Overall this signals the Fed will not be on autopilot going forward," said Justin Lederer, Treasury analyst at Cantor Fitzgerald in New York. The downgrade in the Fed's language around rate increases included a change in its description of economic growth from "strong" to "solid," and it noted that market-based measures of inflation compensation have "moved lower in recent months." The Fed's policy decision was unanimous.

(Reporting by Howard Schneider and Jason Lange; Additional reporting by Jonathan Spicer; Editing by Paul Simao)